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POLITICAL ECONOMY AND FINANCIAL MARKETS

Overall market volatility was somewhat muted today following yesterday’s gains in the stock market. Treasury bond and note prices barely moved at all in today’s session, but the U.S. dollar fell against all major currencies as the report from the Congressional Budget Office has brought reality back to the foreign exchange markets. There was very little today with regard to new economic data for the markets to digest except for all the haggling over the federal budget deficit of $368 billion, an extra $80 billion for Iraq and Afghanistan, and the problems facing the Social Security System. The financial news today was clearly overshadowed by politics as both Democrats and Republicans debate the correct solution for a long-term remedy to our deficits problem. Government revenue needs to increase and spending needs to decrease, but just how we go about getting it done will keep our politicians burning the midnight oil.

It is quite ironic that the financial markets are riddled with political developments in light of the scathing emails I received last week for my “political” commentary. By posting the two BBC articles with a negative slant on President Bush I really stirred-up some readers’ emotions. It was almost comical to see the attacks from Republicans that told me basically that all you Dems are the same, and Kerry would have spent just as much on the inaugural parties. All I could think to myself was yes, I’ve missed voting a few of the presidential elections, but I’ve been a registered republican all my adult life. Frankly, my political disposition favors republican policies (doesn’t really matter what I think about political parties), but things need to change because the deficits keep growing. I still believe the $40 million spent on the inaugural ceremonies was excessive and I would have considered them excessive if Mr. Kerry had done the same. Most Americans agreed that a more subdued celebration would have been more appropriate during wartime.

The main thing I want to address is political considerations when determining investment positions. I failed last week in making my point, so I will now fill in the detail. I looked objectively at what I wrote last week, and I can certainly see why some readers had the perception that I was just taking a cheap shot at President Bush. That was not my objective. In fact the way I see it, it doesn’t matter what the President’s last name is. It could be Bush, Clinton, Reagan, or Kerry, but I learned a long time ago to put “principles before personalities.” The fact remains that a great majority of countries around the globe are very unhappy with the actions of U.S. policy makers led by the President. The survey I posted last week had 16 out of 21 countries showing disapproval of the current administration’s policies. The discontent of these countries has put them in a position where they are finding it more and more necessary to go around the U.S.A. in global trade.

The most ominous development has been the cooperative trade agreements struck between China, Russia, Brazil and India. One analyst writes, “On 10 November 2004, the India Daily reported that, "Russian President Putin is taking a lead role in the most powerful coalition of regional and superpowers in the world. The coalition consists of India, China, Russia and Brazil. This will challenge the superpower supremacy of America." … "He [Putin] wants to establish a long-term Russian footprint in Latin America in order to expand Moscow's geopolitical influence in the region. Brazil is very open to the coalition concept where these large countries support each other in terms of trade, economics, international politics and defense."

Just this single strategic move means that the new coalition embraces just over three quarters of the world's total population, eighty percent of its natural resources, and a majority of technical and scientific experts. Nor does it end there, because the coalition automatically includes the Shanghai Cooperation Organization (SCO), which is presently comprised of China, Russia, Tajikistan, Kazakhstan, Kyrgyzstan and Uzbekistan. Dangerously for America, the coalition will soon have another important member, Iran, currently due to enter informally in a few months time through the SCO "back door" because of a mammoth energy deal. We will return to Iran shortly.”

The author went on to say that Iran is said to be the next country to enter into the Shanghai Cooperation Organization because of a huge deal they have with China to supply liquefied natural gas. Again from the same analyst, “A mere two months ago, the news of a China-Kazakhstan pipeline agreement, worth US$3.5 billion, raised some eyebrows in the world press, some hinting that China's economic foreign policy may be on the verge of a new leap forward. A clue to the fact that such anticipation may have totally understated the case was last week's signing of a mega-gas deal between Beijing and Tehran worth $100 billion. Billed as the "deal of the century" by various commentators, this agreement is likely to increase by another $50 to $100 billion, bringing the total close to $200 billion, when a similar oil agreement, currently being negotiated, is inked not too far from now.

"The gas deal entails the annual export of some 10 million tons of Iranian liquefied natural gas (LNG) for a 25-year period, as well as the participation, by China's state oil company, in such projects as exploration and drilling, petrochemical and gas industries, pipelines, services and the like. The export of LNG requires special cargo ships, however, and Iran is currently investing several billion dollars adding to its small LNG-equipped fleet."

Though America officially refers to Iran as part of the "Axis of Evil," this does not stop it importing very large quantities of Iranian LNG through third parties. Now all that will come to a grinding halt, because Iran must naturally focus exclusively on filling its mammoth Chinese commitments. Thus on 2 December 2004, the block on external energy supplies to America started in earnest.

At the same time, Iran effectively came under China's protection, because any American attack on Iran will impact directly on Chinese National Security by severing its energy resources. It is but a small step for Iran from there to full membership of the Shanghai Cooperation Organization (SCO), and overall protection by the Russian-Chinese Axis.”

Based on some of the events that happened last year and on recent developments, I can only speculate that Venezuela will be the next in line after Iran to join the SCO. President Chavez of Venezuela has become very angry with U.S. policies and has been taking matters into his own hands. A few weeks ago Mr. Chavez took a trip to China to negotiate some large, long-term energy deals. The way I see it, Venezuela will probably be selling more energy products to China in the very near future. I heard on CNBC today that Venezuela was expected to double their oil output in the next five years, but can’t get the job done without help from outside the country. Yesterday the New York Times ran an article, Venezuela Tensions Worry Oil Executives. “Venezuela may be increasing tension in energy markets with decisions that are confounding international oil companies, but the government there says it is merely seeking more income and new markets for its oil…Concern is also rising over the possibility that Venezuela may eventually divert shipments from the United States, which now receives more than half of Venezuela’s total production. The Venezuelans say they still consider the United States their principal market, adding that only new production would be moved to China.” This is already having an impact on the U.S. in that ConocoPhillip’s plan to develop a new oil field in Venezuela was suspended about two weeks ago while Venezuela continues negotiations with China.

The way I understand it, China wants to provide Venezuela with the capital and even some of their workers to further develop the oil fields. China would get the fuel they need for a hungry nation while Venezuela gets the seed money to develop their resources and at the same time Mr. Chavez gets a dotted-line to military protection from China just as Iran has arranged. The air is getting pretty thick globally! In fact, Mr. Chavez must be feeling a need for more security since Venezuela has recently made arrangements with Russia to purchase 50 Mig 29 SMT’s, the very latest in Russian technology with enhanced attack payload package. Mr. Chavez must be thinking it will be tough to get spare parts for his currently aging fleet of F-16’s.

Though I believe these things to be true between China and Venezuela, I will need to do more digging to verify all of the specific information. I will also want to do more research to see exactly how this will affect supplies here in the U.S. I did do just a little bit more digging for information this morning, and I found a very interesting little detail on CITGO’s website. In their Investor Relations section they state, “Headquartered in Houston, Texas, CITGO is owned by PDV America, Inc., an indirect, wholly owned subsidiary of Petróleos de Venezuela, S.A. (PDVSA), the national oil company of the Bolivarian Republic of Venezuela.” When I read who owns all the CITGO stations, I had to know how many there are here in the U.S., so I found another site that lists all of the gas station counts by brand. I was surprised to see that CITGO has more locations than any other single brand here in the States. The report shows CITGO with 12,190 stations followed by Exxon with 10,441 and Amoco with 9,760. Here’s the link to the station counts by brand if you are interested to see more. With over 12,000 gas stations here in the U.S., it’s no wonder Venezuela still considers the United States their primary market.

When I posted the global survey last week I was thinking about the global discontent of U.S. policies and how we could be losing out of some big energy deals because of it. I was thinking about all the things I have just mentioned, but due to the controversial subject, decided not to go with all the information on Venezuela. The article I referenced earlier was written by Joe Vialls. Now I am not familiar with his work, and I have to assume it is highly controversial. I suppose some would put him in the category with Art Bell or Jeff Rense. The stuff I wrote last week is baby pabulum compared to the meat and taters you will read in Joe Vialls article linked here. If you want to get really fired-up on some political stuff just read the essay, but don’t blame me for the title! In order to get the information you have to have an open mind and read through some of the things you might think the guy is whacko about.

One of the most important things to note is the date that he wrote the article. He posted his analysis on December 24^th, and I received it from one of my “internet” friends on December 29^th. I have not been hearing much about all these developments in our mainstream media, but I did find three articles that just appeared in the last few days. I mentioned the New York Times article earlier, so here’s the link. If you read the Joe Vialls version, please compare it to the information presented in the N.Y. Times article and remember the N.Y. Times article comes a full month after Joe Vialls presented his case. I have to believe this information was known by our intelligence networks, but it didn’t make it to the media for another month. I found articles similar to the N.Y. Times version in the Houston Chronicle yesterday and another in the International Herald Tribune today, but they were nearly identical to the Times article. (Part of message discipline for our managed press)

From a trading perspective I have been stalking the energy complex through the correction from the highs that were reached back in October last year. With regard to crude, in December I said the bottom was in for oil at $40, and it should be higher from there as the Saudis needed to cut back on production for fear of stressing their wells with the injection of sea water to increase production. On December 29^th I received the information on the potential conflict of Venezuelan supply issues and it was the final piece I needed to have enough confidence to take a trading position in energy. Because Venezuela also provides the U.S. with finished products, I thought this could possibly cause a problem with distillate inventories. In the big picture I’m comfortable with the fundamentals of supply and demand to hold a bullish position in energy. At the same time back on the 29^th, I was happy to see the technical chart set-up, especially with the divergence of a lower price with higher momentum readings. The bullish divergence combined with good fundamentals were great, but the political developments were the final straw that gave me the courage to buy options on futures contracts for unleaded gasoline on 12/29/04.

Source: TFC Commodity Charts

With momentum indicators approaching overbought conditions I wanted to get out of the way of the inventory data that was to be released today and take my gains with over 70% profit for the trade. (I could have done better, but I made the mistake of going out too far on the contracts…should have been closer to the market.) I sold the options yesterday so I was chomping on the bit this morning to hear the inventories, but had to wait patiently…

As I said earlier, it is ironic that there is so much political haggling in the financial markets today with the federal deficit and Social Security reform. I usually hear the energy inventory data first on CNBC before they come out in print, but today CNBC didn’t report until about a half-hour after the data was released because President Bush had a political press conference that took precedent over the data from the Energy Department. Go figure. All the nasty mail I got last week said to stay out of politics and stick to the financial markets. I study fundamental analysis, technical analysis, political developments and investor sentiment all in an effort to minimize risk and maximize profits. Sorry I got so many people bent out of shape last week, but it is what it is! I should have been more specific about how the global discontent identified in the survey could have an impact on our country and especially on our investments. Oil is very political, and it’s tough to invest wisely in the energy markets unless we have a good handle on political developments. If you own any shares in ConoccoPhillips, it would be wise to stay abreast of the situation in Venezuela.

Moving On

Now here comes the broken record with Treasury auctions. At the top of the WrapUp I said volatility was notably low today, but it comes as no surprise when we see the Treasury is busy auctioning $24 billion in two-year notes. The 30-year bond closed a few ticks higher today, with the five and ten-year notes a few ticks in the red…basically no change from yesterday. The dollar didn’t fare quite as well, dropping by more than one percent versus the pound, yen and Australian dollar. The euro closed roughly a penny higher at $1.3077. Stocks held their gains from yesterday, especially the NASDAQ issues as they play catch-up with the big caps in the Dow Industrials. Today the DJIA added 37 points (0.4%) to close at 10,498, the NASDAQ Composite was stronger with a gain of 26 points (1.3%) to 2,046, and the S&P 500 split the difference by adding five points (0.5%) to close at 1,174. I still believe this to be a dead-cat bounce (short covering) before the correction resumes.

The Mortgage Bankers Association said 30-year fixed rate mortgages dropped last week from 5.64% to 5.58%. The MBA application index fell 3.6% with the purchase index down 2.0% and the re-fi index down 5.7%. This is the fourth decline in the last five weeks for the applications index and it comes on the heels of a report yesterday that existing home sales have slowed more than expected. Real estate could well be showing signs that this long run-up in real estate prices might be getting a bit weary. I have received numerous emails from realtors that the markets are beginning to soften, especially on the very high end with listings taking much longer to sell.

Tomorrow we will get the initial jobless claims along with some new data for durable goods orders. In the meantime I will continue stalking the energy complex and precious metals for good investment opportunities as well as good trading positions. I’m happy with the gain I had on the unleaded contracts, and plan to use the proceeds to either re-load the position on a pull-back or use it to continue building my position size in silver. On the equity side, it has been a trying time if you are invested in the precious metals arena. I am still of the belief that patience will be rewarded for those that can hang in there through the tail end of the current consolidation…another week or two should do it! In the meantime…

Have a Great Evening!

Mike Hartman

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